Question

A firm’s total cost per month is $24000 including $12000 as total fixed cost and remaining as total variable cost. Firm produces 1000 units of the product every month in a competitive environment where it is a price taker. Firm’s per month total revenue is $30000. Some thing went wrong and firm’s total revenue dropped from $30000 in October to $ 21000 in November. Should the firm shut down or not and why? The manager of the firm knows that total revenue of the firm will further decrease to $10000 in December. What is the best decision manager will take and when and why?

Answer 1

Answer : Here quantity level is 1000 units.

Total Cost = $24,000

Average total cost = Total cost / Quantity = 24000 / 1000 = $24

Total variable cost = Total cost - Fixed cost = 24,000 - 12,000 = $12,000

Average variable cost = Total variable cost / Quantity = 12,000 / 1,000 = $12.

For $21,000 total revenue :

Total revenue = Price * Quantity

=> 21,000 = Price * 1,000

=> Price = 21,000 / 1,000

=> Price = $21.

As in case of $21,000 total revenue the price $21 is lower than the average total cost of $24 hence at $21 price level the firm faces loss. But as the price $21 is higher than the average variable cost of $12 hence the firm should continue it's production.

For total revenue of $10,000 :

Total revenue = Price * Quantity

=> 10,000 = Price * 1,000

=> Price = 10,000 / 1,000

=> Price = $10.

When price is lower than the average variable cost then the firm face extreme loss situation. As in case of $10,000 total revenue the price $10 is lower than the average variable cost of $12 hence the manager should take a decision to shutdown the firm's production.